Small Caps | Jun 26 2023
This story features JOHNS LYNG GROUP LIMITED. For more info SHARE ANALYSIS: JLG
Brokers explain a negative share price reaction to Johns Lyng’s upgraded FY23 guidance.
-Upgraded revenue and earnings guidance for Johns Lyng
-Higher CAT guidance expected, while BaU disappoints
-Bell Potter lowers its rating for the company on El Nino
-Lower broker targets, but a generally positive outlook
By Mark Woodruff
Last week, revenue and underlying earnings guidance at Johns Lyng Group ((JLG)) were raised by around 10% apiece, due to increasing catastrophe (CAT)-related volumes which are expected to boost FY23 revenue by $100m.
However, the share price reaction was decidedly negative as 23% business-as-usual (BaU) growth fell well short of expectations held by some brokers.
The company is the market leader in Australia for insurance building & restoration services (IB&Rs), with a growing presence in the large-scale US market.
More than 70% of earnings derive from the annuity-style BaU work, with CAT earnings providing optionality over large-scale insured weather events. For example, management expects around $150m of work in the next two-to-three years from Hurricane Ian (in Florida) alone.
The company highlighted integration in the US is tracking to plan, with CAT now a leading line of business.
It should be noted, the above guidance excludes the impact of the discontinued Commercial Construction Services (CCS) division, which has been impacted by fixed-price building contracts in a high cost inflation environment.
Evans and Partners suggests the upgrade to CAT numbers was already generally expected by the market.
While an uplift in this guidance was above Citi's expectations, BaU continues to take centre stage for this broker given CAT’s innate volatility.
To reflect a slower ramp-up in the BaU growth profile, Citi cuts its FY24 and FY25 revenue forecasts and lowers its 12-month target price to $6.50 from $9.65.
While the CCS losses were more than the -$10m previously guided for, Moelis believes these should be regarded mostly as a one-off, as current projects are wound down. It’s thought losses will ease to -$3m in FY24.
Across BaU (excluding CCS), FY23 guidance implies to this broker half-on-half earnings growth of around 12% across the second half.
Even though CAT revenues have come down from a first half peak, Moelis anticipates the run-rate will remain elevated through FY24 due to growth in the US and New Zealand. Moreover, CAT revenues are expected to benefit from 2022 floods works moving into the rebuilding phase, and should gain from an expanding scope within the government disaster recovery division.
While Bell Potter’s BaU forecast was also missed, the broker suspects the relative infancy of the company’s US business drove most of the margin compression experienced in the second half, due to front-loading of start-up costs to set up the company’s ‘full service’ proposition.
Of greater concern to this broker, which downgraded its rating to Hold from Buy, are expectations for a softer domestic demand outlook heading into El Nino. Falling property claims values have been observed in four of the last six events.
While ocean and atmospheric indicators of La Nina have remained at neutral levels through autumn, recent forecasting by the Bureau of Meteorology indicates that El Nino thresholds will likely be met or exceeded by June 2023.
Certainly, if El Nino come to be, Evans and Partners believes FY23 is likely to represent the peak for Johns Lyng in the current cycle.
It’s not that CAT revenue is lower quality than BaU revenue, according to the analysts, but rather it has created a high bar that will be difficult to eclipse in the face of an emerging El Nino.
While growth catalysts remain intact for Johns Lyng, Citi believes cautious sentiment will prevail on BaU until there is concrete evidence of sustainable and strong growth.
Nonetheless, it’s thought sentiment on the stock could be lifted when there is evidence of the US growth strategy being delivered.
Canaccord Genuity expects Johns Lyng will enter FY24 with already strong momentum across the business and with a record level of CAT-related work in hand and pipeline of opportunities.
This incorporates an expanding CAT opportunity emerging from preventative and resilience programs, including the Federal Government’s Disaster Ready Fund (DRF), explains Canaccord. This fund was established to provide up to $200m/year over five years (commencing in 2023/24) for natural disaster resilience and risk reduction.
Macquarie points out demand for Johns Lyng’s services is non-discretionary and the pricing model is largely cost-plus. This broker anticipates delivery of attractive growth in BaU revenue and earnings going forward and expects management will reiterate its growth outlook at the FY23 result release.
FNArena's daily monitoring consists of Buy-rated Macquarie and Citi, along with Bell Potter (downgrade to Hold from Buy) which actively cover Johns Lyng. The average target price is $6.63, down from $8.28, which suggests nearly 29% upside to the latest share price.
Buy-rated Canaccord Genuity and Moelis, along with Evans and Partners (Neutral) are not monitored daily. These brokers have an average target of $7.30, while Goldman Sachs (Buy; target $9.25) is yet to update its research following the new management guidance.
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